In many markets, the risk associated with default by a trader's counterparty is addressed by a broker or other centralized entity that stands behind every transaction and assumes the risk associated with such default. In other markets, however, such as markets for trading interest rate swaps where the potential for default extends long into the future, such an arrangement is not practical. Instead, those markets have developed bi-lateral credit arrangements where each trading entity specifies maximum amounts of credit that it is willing to extend to its potential counterparties. Electronic trading systems that incorporate credit modules to store and apply these credit limits have also been developed and are widely used today.
These systems, however, do not accurately account for the actual risk to a party in executing any given trade but rather seek to limit overall risk to the party through the application of appropriate credit limits. Creating a system that deals with transaction risk on a trade-by-trade basis presents several issues. These include designing an appropriate risk model that will accurately reflect the risk to each trading participant in any given transaction and will furthermore be suitable for implementation in an electronic trading system. Technical problems relating to the design of system architecture and components are also presented since it is desirable for each trading participant to be able to apply its own risk algorithms and methodologies to assess credit risk while avoiding the disclosure of such algorithms and methodologies to other trading participants.